SEC Accuses Big 4 Affiliates of Blocking China Audit Probes

U.S. regulators probing potential fraud by China-based companies increased pressure on their auditors by formally accusing affiliates of Big Four firms of withholding documents from investigators.

Deloitte Touche Tohmatsu CPA Ltd., Ernst & Young Hua Ming LLP, KPMG Huazhen and PricewaterhouseCoopers Zhong Tian CPAs Limited have refused to cooperate with accounting fraud investigations into nine companies whose securities are publicly traded in the U.S., the Securities and Exchange Commission said in an administrative order Monday. BDO China Dahua Co. Ltd. was also named by the SEC in the action.

China-based companies listed on U.S. exchanges have faced increased scrutiny over the past two years after regulators became concerned that some firms may not be providing accurate financial statements to investors. Investigators have struggled to obtain documents central to the probes because auditors, citing China’s laws, have declined to cooperate.

“Only with access to work papers of foreign public accounting firms can the SEC test the quality of the underlying audits and protect investors from the dangers of accounting fraud,” SEC Enforcement Director Robert Khuzami said in a statement. “Firms that conduct audits knowing they cannot comply with laws requiring access to these work papers face serious sanctions.”

Ernst & Young LLP will pay $117 million to settle claims in a Canadian class-action suit that Sino-Forest and some of its directors and officers, auditors and underwriters misled investors about business and accounting at the now insolvent Chinese timber trader, Siskinds LLP and Koskie Minsky LLP, the law firms behind the action, said in a statement Monday.

Fraud Cases

The SEC has de-registered the securities of nearly 50 companies and filed fraud cases against more than 40 issuers and executives as part of its investigation into the non-U.S. based issuers. Many of the companies entered U.S. capital markets through so-called reverse mergers, in which a closely held firm buys a shell company already listed on an exchange, allowing them to sell shares without the scrutiny that would surround a public offering.

Earlier this year, the agency announced a separate enforcement action against the Shanghai-based Deloitte affiliate after seeking to enforce a subpoena in federal court.

‘Applicable Laws’

“Ernst & Young Hua Ming supports close working relationships between regulators to enable them to cooperate and share information with one another,” Will White, director of global and EMEIA media relations for Ernst & Young, said in an e-mail statement. “We hope that an agreement can be reached between U.S. and Chinese regulators that will enable our compliance with all applicable laws and regulations.”

Geoffrey F. Aronow, an attorney for KPMG at Bingham McCutchen LLP, declined to comment. An e-mail sent after working hours to KPMG China spokeswoman Nina Mehra wasn’t returned. An e-mail to a lawyer for BDO wasn’t returned.

“The fact that the action is being taken collectively against all of the four largest audit firms and one other firm demonstrates that this is a profession-wide issue,” Caroline Nolan, a PricewaterhouseCoopers spokeswoman, said in an e-mail statement. “For its part, PwC China has cooperated with the SEC at every opportunity. However, PwC China will, and must, comply with its legal obligations under China law.”

Lauren Mistretta, a Deloitte spokeswoman, also said the issue needs to be resolved on a “profession-wide basis.”

“While it is unfortunate that the two countries have not yet been able to find common ground on these issues, we remain hopeful that a diplomatic agreement can be reached,” Mistretta said in an e-mail statement. “We stand ready to assist that effort in any way we can.”